The emergence of intra-firm trade as the primary component of international trade reflects a global interdependence in the production process. In this column the former Director-General of the WTO argues that this necessitates a re-examination of how we think about – and how we measure – trade between nations. Interdependence allows different sectors to add value, and complicates the implementation of trade barriers. Only with a modern perspective can effective trade policy be conducted.

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Today, the expansion of global value or production chains means that most products or services are assembled with inputs from many countries. We may still think in terms of Ricardo’s world of trade between nations, but in reality most trade now takes place within globe-spanning multinational companies and their suppliers. The results of this ‘trade in tasks’ are all around us.

With value chains, it is no longer necessary to be competitive in producing a particular product or service; it is enough to be competitive in delivering a particular task. The growing weight of services in the business portfolios of countries and the increase in the reach of technology and transportation are fast narrowing the distances between and to markets and creating new opportunities for all countries (developed or developing) to grow through trade.

The changing geography and composition of trade

Twenty years ago, 60% of world trade was between developed countries (North–North), 30% was between developed and developing countries (North–South) and 10% was South–South. By 2020, we are expecting it to be split equally three ways, so the relative weight of North–North trade will have been halved in just 30 years or so.

Interestingly, almost 60% of trade in goods is now in intermediates, i.e. goods used as inputs in the production process. An important consequence of the integration of production networks is that imports matter as much as exports when it comes to contributing to job creation and to economic growth. In 1990, the import content of exports was 20%; in 2010, it was 40%, and it is expected to be around 60% in 2030. This is why enacting ‘protectionist’ measures in the modern world to protect jobs – such as raising import barriers – can have an inverse reaction in economies that are increasingly reliant on imports to complete their exports. This narrative is already transforming the policy debate on trade and should lead to more nuanced and evidence-based decisions that reflect more truly the impact that trade can have on growth, employment, and innovation. In effect, we are seeing the end of the centuries-old doctrine of ‘mercantilism’, which proclaimed that a country’s economic strength depended on it being able to export more than it imported.

All this confirms that the way we measure trade needs to change. Our traditional methodology assigns the total commercial value of an import to a single country of origin.

This was an accurate formula when trade just involved final goods produced from domestic inputs. It might even have worked when imported raw materials were processed in a single country. But when applied to ‘made in the world’ products, such as the iPhone, the methodology can exaggerate bilateral trade balances and understate where value addition occurs. This incongruence has two main results. It can exaggerate trade between countries, leading to anti-trade sentiment, and it can generate policies that do not reflect the pace, direction, and reality of world production and trade. Having an accurate, evidence-based measure of the true value of trade is necessary if policy makers are to make informed decisions on trade and economic policy.

'Made in the World' initiative

I realised several years ago that the trade negotiations being carried out at the WTO – aimed at modernising international rules to better reflect the realities of the 21st century – were still based on a 19th century view of international commerce. This has certainly had something to do with the difficulties that negotiators have had, and are having, in bringing the Doha Round to a successful conclusion (although the recent Bali agreement is a welcome step forward). But international statistical conventions take years to change and we cannot wait. This is why I asked the statisticians at the WTO to find a way to bridge the gap with the necessary statistical tools. Since then, the 2008–09 global financial crisis and the accompanying Great Trade Collapse have concentrated the attention of analysts on the importance of this issue.

Statisticians essentially needed to reinvent the system of national accounting to take account of industrial interaction between the different areas of the world. The basic idea is simple and dates back to the work of Nobel laureate Wassili Leontief in the 1960s. You create a giant international input output matrix to describe all inter-industry trade preceding production and consumption of a final good or service. The idea may be simple, but putting it into practice is complicated.

World input-output tables

Without going into specifics, the implementation of such a tool requires not only proper harmonisation of each of the partners’ national accounts, but also a detailed analysis of the use of the goods and services traded, either for consumption or investment purposes, or for further use in a new productive process. The latter case is, of course, crucial because it is indicative of international trade in the context of value chains: you import an intermediate product – whether a good or a service – to which you add value before re-exporting it or using it domestically, whether for consumption or for incorporation in a new productive process. Knowledge of the value-added content of exports provides a means of avoiding double counting when intermediate components cross several borders before reaching their final destination. It also makes it possible to ascertain the portion of commercial value recorded at each customs point that is attributable to the exporting country – namely the processing of imported inputs – and what constitutes re-exportation of foreign components. This value addition can be further broken down between the own assets of the industry directly responsible for the exports and the indirect value-added contributions attributable to the domestic suppliers of the enterprise concerned.

Japan’s Ministry of Trade and Industry had already done some pioneer work on inter-industry trade in South-East Asia, which had been supplemented by what is known as the World Input-Output Database (WIOD) initiative, a European project co-ordinated by the University of Groningen in the Netherlands. Thanks to this project, major statistical advances were made. The WTO teamed up with the OECD to initiate co-operation in further statistical and analytical work. By late 2012, this work on the methodology had made enough progress for the OECD and the WTO jointly to decide to make available to the general public a database of international trade measured in terms of value added.

What do these new trade figures tell us?

First of all, they provide a map of international trade that vastly differs from the previous one. Let’s take the example of services. Services are often described as the poor relation of globalisation; even agriculture, which accounts for 7% of international trade, receives closer consideration. And yet, take a look at where value added in international trade comes from today and you will frequently find a services provider. In fact, services are at the very heart of value chains, whether national or international, because the provision of industrial or commercial services, such as information technology (IT) and factoring, marketing, logistics, assembly and distribution, after-sales service and so forth, is often sub-contracted. Accordingly, services are thus the chief contributors to global trade, while manufacturing industry’s share declines in the same proportion.

What does this mean?

One lesson is that to be able to export, you must know how to import. When an industry’s competitiveness relies on the cost effectiveness of the components and intermediate goods and services making up the production chain, strong performance in all segments of the value chain is essential. Indeed, there is a positive correlation between the buoyancy of a country’s exports and its integration in value chains through imports of intermediate goods. Importing competitive components where necessary enables developed-country firms to generate margins for investing in those segments where their real comparative advantages lie. Far from killing jobs, this enables Europe, the US, and Japan to maintain industrial activities linked in particular to research and development, industrial engineering, and high value-added services. These are the activities that can and will generate the best-paid jobs.

Another important point is that global trade is also changing in terms of the obstacles it faces. Tariffs and non-tariff contingency measures – including antidumping duties and safeguards – traditionally formed the principal barrier to trade. They were the focus of international trade negotiations, but in recent years, so-called non-tariff measures – such as technical standards, health and safety requirements, and services regulations – have loomed ever larger. With the expansion of global production sharing, product and process standards are becoming increasingly relevant in linking various stages of global value chains.

Quality concerns take a more central role in policy as economies develop and become more interdependent, and as incomes grow. Today, non-tariff measures are more prevalent in the richer countries but the trend is present in practically every economy. These concerns over standards are wholly legitimate and cannot, indeed should not, be blindly trumped by a desire to keep trade completely unobstructed. That said, the nature of the measures taken to pursue public policy objectives in health and other areas, and the way these measures are administered, can have widely varying effects on trade, both positive and negative. We can agree that it is desirable to ensure that non-tariff measures do not increase trade costs more than the minimum necessary to achieve their objective. Similarly, it is reasonable to argue that such measures should not be constructed in ways that unduly favour domestic interests. Yet, in light of the complex objectives and policies in play where these policies are concerned, finding the right balance is not easy. It requires co-operation and dialogue.

Trade effects of public policies: Four complicating factors

Our understanding of the trade effects of public policies is complicated by four factors.

First, the effect of technical measures, such as those covered by the WTO agreements on sanitary and phytosanitary measures (SPS), and on technical barriers to trade (TBT), depends significantly on how they are applied, or administered.

Evidence from business surveys shows that procedural obstacles, such as conformity assessment procedures, can be a major source of difficulties for exporting firms.

Second, while public policies need not be trade distorting or trade restricting in and of themselves, they may be designed in such a way as to impart an intentionally protectionist effect, while serving a public policy objective.

Such measures assume a ‘dual purpose’, and this interface between public policy and protectionism poses an important challenge for the WTO and has been at the heart of a growing number of trade disputes.

Third, even in the absence of protectionist intent, national policies that result in regulatory discrepancies can substantially raise trade costs and reduce or distort trade flows.

There are various reasons why national policies may diverge. Different regulatory approaches may not be intentional, but rather rooted in habit or custom. Divergence between national or regional public policies may also reflect different social preferences. In other words, value systems among societies may vary, giving rise to contrasts in approaches that can be difficult to reconcile.

While it can be argued without too much controversy that it is desirable to reduce the deadweight costs of inefficient systems, or to address protectionist measures hidden behind legitimate public policy interventions, it is by no means obvious that we can argue for uniformity in the substantive objectives behind public policy, even if differences impact trade. Here, the challenge is more nuanced. We would like to minimise incidental divergence, but trade can hardly trump social preferences in matters of public policy. In these circumstances – where genuine differences prevail in public preferences and objectives – regulatory harmonisation or mutual recognition arrangements may be a better avenue. But what is clear is that greater political energy is necessary to reduce these divergences in order to level the playing field.

The fourth reason why non-tariff measures can be difficult to gauge in terms of their trade impact relates to measurability.

With tariffs, it is a relatively straightforward matter to estimate trade impact. Non-tariff measures are much harder to assess in these terms. But we can start by improving transparency about them. During my tenure at the WTO, I launched the Integrated Trade Intelligence Portal (I-TIP), a one-stop shop for accessing all information notified to the WTO by members, including about non-tariff measures, tariffs, trade remedy use and trade statistics. For the first time, it became possible to access the entire trade regime of a country.

Concluding remarks

Looking ahead, it seems to me that with non-tariff measures we need to reflect more carefully on our core culture and approach to trade opening. A new horizon and context must be defined. With tariffs and quotas, the long-term objective of negotiations has been their progressive reduction or elimination. Public policies, such as health, cannot simply be reduced and eliminated. This re-orientation in our thinking is a basic challenge. In an era where public policies move centre-stage in trade politics, the objective of trade opening and the pursuit of opportunities stemming from specialisation through trade requires a clear understanding of how, when, and where regulatory convergence should be promoted.